FINANCIAL RISKS FROM CLIMATE CHANGE

FOR REAL ESTATE COMPANIES

2021
CONTENTS

1 Executive Summary

2 Introduction

3 Climate change risks impacting the real estate sector

3.1 The climate physical risks
3.2 The climate transition risks
Policy and regulatory risks – Worldwide
Policy and regulatory risks – European Union
Market and reputational risks
Technology risks
Warming Potential
3.3 Impact of climate change on long-life fixed assets

4 Transition to a climate resilient real estate sector

4.1 Mapping financial risks
4.2 Social impact considerations

5 Key recommendations and foresight

5.1 Developing a sustainability strategy
5.2 Incorporating climate financial risks and following TCFD recommendations
5.3 Developing sustainable properties and applying circular technologies
5.4 Facing sustainability as a financial leverage aspect
5.5 Reporting on sustainability practices

6 Final Remarks

Bibliography

FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 2

EXECUTIVE SUMMARY

01 EXECUTIVE SUMMARY

THE FINANCIAL RISKS FROM CLIMATE CHANGE

Climate change carries financial risks that are increasingly recognized by major global organizations, such as the
Financial Stability Board (FSB), the World Economic Forum (WEF) and the Organisation for Economic
Co-operation and Development (OECD). Climate risks can be physical or transition related. While the first result
from direct consequences of climate change, like the increased frequency and intensity of extreme weather
events, droughts, or floods; the latter are connected to augmented regulations on climate, or to changing
technological or reputational issues, that have an impact on companies, financial institutions, and the overall
society. Both lead to serious changes in market dynamics that are likely to create new winners and losers in
different economic sectors.

THE REAL ESTATE SECTOR AND CLIMATE CHANGE

The European Union (EU) and some of the most developed nations worldwide are setting ambitious carbon
neutrality commitments for the next decades, pushing for improved climate policies, promising to put an end to
“business as usual”. In the EU (with a similar pattern in other countries), the real estate sector is responsible for
approximately 40% of the overall energy consumption and 36% of CO2 emissions, which sets it as one of the
main targets for these new policies and regulations.

TRANSITION RISKS WILL HIT, HARD AND SOON, THE REAL ESTATE INDUSTRY
It is paramount to understand certain initiatives, policies and regulations, deriving from the European Green
Deal, the EU taxonomy for sustainable activities, or the Renewed EU Sustainable Finance Strategy, among
others, that call for the urgency about the decarbonization of the sector. They encompass measures such as the
higher renovation rates of the building stock, the need to create mitigation and adaptation actions to climate
change, and the importance to perform environmentally sustainable real estate activities and investments.
Moreover, key attributes like the inclusion of climate-related risks in financial ratios and reporting for real estate
portfolios and the assessment of the adverse sustainability impacts of real estate assets are highlighted, with a
focus on sustainable construction and renovation, and the usage of circular economy principles and processes.

FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 3

EXECUTIVE SUMMARY

01 EXECUTIVE SUMMARY

THE FINANCIAL AND SOCIAL IMPACTS OF CLIMATE CHANGE FOR REAL

ESTATE COMPANIES
Real estate companies carry specific climate physical risks, with potential negative financial impacts. Firstly, the
sector is usually connected with longer investment cycles, which means that physical risks of climate change that
are likely to arise in the medium and long run should start to be taken into consideration in the face value of
today’s investments. Secondly, they have a relative illiquidity due to the physical permanent location of the
assets. As such, as extreme weather events increase in frequency and intensity, and as overall temperature
increases, real estate investors will face higher asset impairments, operational costs, and, consecutively,
increased insurance premiums and capital costs. This is especially true for buildings in coastal areas where 40%
of the global population resides, with alarming sea level rise predictions related with climate change, affecting
the lives of millions of people. Therefore, real estate companies should also consider key social impact drivers
that play an important role in designing appropriate answers to climate change known consequences.

THE REAL ESTATE SECTOR RESPONSES TO FACE CLIMATE CHANGE

CHALLENGES
A climate-change driven sustainability strategy and plan is essential for real estate companies to develop,
incorporating financial climate risks in the investment analysis, following TCFD recommendations and applying
climate risk modelling practices for a greater risk understanding and assessment. Furthermore, investing in
buildings’ energy efficiency, renewable energy sources, and circular and low-carbon technologies is the way to
go, facing sustainability as a financial leverage positive aspect for access to capital, whose measures should be
contained and described in the annual non-financial reports. A constant alignment and update according to
international standards, best practices and regulations is key, to effectively face the challenges posed by climate
change, towards promoting a more climate resilient real estate sector.

FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 4

INTRODUCTION
02
An overwhelming majority of
climate scientists (97%) are
certain that climate change
is due to anthropogenic fac-
tors (activities originated by
human intervention)1 and that
it will result in increasing ad-
verse consequences for the
natural world and the global
economy. To confirm that, the
latest Global Risks Report of
2021 of the World Economic
Forum (WEF) has placed cli-
mate change at the top of the
risks to be tackled2. Phenome-
na such as the rise of global
average temperature, natural
disasters becoming more
frequent or the disruption of
ecosystems, together with
the impact on human health
brought by the pandemics,
pose increasing risks for busi-
nesses. All of these have nega-
tive impacts in most sectors,
but the real estate sector will
be one of the most impacted
according to another recent
WEF study about the rising
nature risks and their impact
in the global economy3.
To understand financial risks
resulting from climate change,
the Task Force on Climate
Change (TCFD) launched by
the Financial Stability Board,
released the Recommenda-
tions of the Task Force on
Climate-related Financial Dis-
closures report, identifying
the main risks, opportunities
and financial impacts from
climate change (see Figure 1).
The report defines two types
of risks:
1) Transition risks, related to the transition to a lower-carbon economy, motivated by changes As of 2019, the size of the pro- From 2012 to 2018, total assets in sustainable investing
in structural aspects such as new policies and laws, upcoming technologies, changing market fessionally managed global have more than doubled, highlighting the strong growth
dynamics or reputational effects; real estate investment market in some of the global largest economies (e.g. Europe,
was worth USD$9.6 trillion6 USA, Japan, Canada, Australia and New Zealand)8. The
2) Physical risks from climate change, that can be: acute, such as extreme weather events; Real Estate is a significant as- expectation is that the market will grow 55% in 2021,
or chronic, related to the long-term consequences of temperatures’ increase, resulting in phenom- set class and long-life fixed as- according to Crédit Agricole CIB 9. Real estate invest-
ena such as sea level rise, floods and biodiversity losses. sets should consider climate ments are a crucial part of the portfolios of many in-
change-related vulnerabilities vestment funds, whose managers should be able to
This TCFD report4, as well as the Network of Central Banks and Supervisors for Greening the Fi- and exposure to both physi- understand the climate-related risks and reporting in-
nancial System (NGFS), recognizes climate change as a source of financial risk, and that a set of cal and transition risks7. formation that investors will demand for, implementing
measures must be taken to minimize such risks5. management systems that allow such information to
In the real estate sector, cli- be disclosed in an automatic and frequent way.
mate-related risks can im-
pact the face and market
value of the assets, and fi-
nancial valuations should
include the future impacts
FIGURE 1: CLIMATE-RELATED RISKS, OPPORTUNITIES AND of climate change in those
FINANCIAL IMPACTS (TCFD) assets, as of today’s prices.
Giving a straightforward ex-
ample, if a real estate asset
is close to the sea, it has an in-
creasing probability of being
hit by waves, which may lead
to the impossibility of obtain-
ing insurance. Hence, this
physical risk exposure will
have an impact on the insur-
ance of that particular asset.
Climate events can also
have expensive maintenance
and operational costs. In a
worst-case scenario, a nat-
ural disaster could cause
a complete property loss.
That is why investors are de-
manding more environmen-
tal information before decid-
ing which assets to buy or
sell. Therefore, worldwide,
there is an increasing num-
ber of investors looking for
Source: TCFD, Recommendations of the Task Force on Climate-related Financial climate resilient companies.
Disclosures, 2017
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 5
CLIMATE CHANGE RISKS IMPACTING THE REAL ESTATE SECTOR
03 3.1 THE CLIMATE
PHYSICAL RISKS
The average world temper-
ature has already gone up
compared with the prein-
dustrial baseline of 1720 to
1800, and will go up at least
1.5°C to 2ºC by the end of
this century10 (in the Mediter-
ranean already went up by
1.4°C) 11. The rising frequen-
cy and intensity of storms,
floods, fires, and strong
winds is already having a fi-
nancial impact. According
to the European Commis-
sion, between 2000 and
2016, annual weather-relat-
ed disasters worldwide rose
by 46%. Between 2007 and
2016, economic losses from
extreme weather world-
wide rose by 86%, reaching
a cost of €117 billion in 2016.
The EU acknowledges cli-
mate change as a high pri-
ority, since close to 50% of
the exposure of Euro area
banks is directly or indirect-
ly linked to risks stemming
from climate change12.
As hurricanes, wildfires and
storms become more fre-
quent, the real estate sector
will suffer direct value impair-
ments of assets, increased in-
surance costs and reduced
insurance availability.
Globally, in 2017, insurers
paid a record USD$136 bil-
lion for damages caused
by natural disasters 13. Insur-
ance companies have al-
ready stated that climate
change may make build-
ings uninsurable. Global
leading insurers signalled
that, in a 3°C or 4°C scenar-
io, some buildings in cities
like New York and Mumbai
will no longer be insurable 7.
Moreover, gradual chang-
es in climate will lead to in-
creasing operating, main-
tenance and again, insur-
ance costs, and may even
mean adaptation meas-
ures such as elevating build-
ings in coastal areas, in
order to deal with sea level
rise. There is an increasing
frequency of heavy rain
and wind, long periods of
draughts, higher tempera-
tures and decreasing rain-
fall. The financial impacts of
these are already being felt
by the sector. Studies pub-
lished by the Urban Land In-
stitute in partnership with
Heitman in 2017 and 2018,
found that “homes exposed
to flood risk or sea-level
rise have sold for less than
comparable properties or
have seen values increase
at a reduced rate in compar-
ison to similar properties
without flood risk”.14
Also, according to the Glob-
al Commission on Adapta-
tion, this could force “hun-
dreds of millions of people
living in coastal areas to
leave their homes, with total
costs estimated at USD$1
trillion each year by 2050”.7
This is particularly relevant,
since that according to the
United Nations, by 2007, it
was estimated that “40% of
the world population lived
within 100 kilometres of a
coast”15.
Other consequences in-
clude increasing energy de-
mands for cooling and heat-
ing, and losses of labour pro-
ductivity. The first will lead
to boost energy efficiency
solutions in buildings. The
second is related to heat
stress. Statistics also show
a 1% to 5% decrease in con-
struction labour productivi-
ty, depending on different
geographical areas16.
Indirect risks also include
the decrease in real estate
asset values, generated by
the possible GDP impacts
of physical climate-related
events, which may be felt di-
rectly or indirectly, through
supply chain impacts. The
real estate sector and com-
panies must understand
the risks of occurring such
phenomena in specific are-
as and existing buildings, so
that they can become more
resilient to those impacts.
FIGURE 2: SUMMARY OF THE IMPACTS OF THE PHYSICAL RISKS OF
CLIMATE CHANGE FOR THE REAL ESTATE SECTOR
Value impairment
of assets
Loss in labor
productivity
3.2 THE CLIMATE
TRANSITION RISKS
The climate transition risks po-
tential impacts are increasing
due to the growing pressure
that governments and regula-
tors are placing in financial in-
stitutions to increase transpar-
ency on their activities and
respective clients’ business-
es, aiming at being resilient to
face climate change-related fi-
nancial impacts.
In 2015, the world has com-
mitted to reach carbon neu-
trality during the second half
of this century with the signa-
ture of the Paris Agreement
(PA), a United Nations initiative.
Europe is committed to reach
that goal in 205017 and China
in 206018. Therefore, one of the
major risks is coming from the
regulators sphere in Europe,
USA and other parts of the
world, namely from China
and India, which are develop-
ing public policies to lead their
countries to carbon neutrality.
Higher capital Higher operational Asset value
expenditure costs decrease
Higher energy
consumption Increased insurance Reduced insurance
in buildings premiums availability
Real estate is responsible for
“approximately 40% of the over-
This is being acknowledged
not only by governments,
all energy consumption and but also by international
36% of CO2 emissions in the regulatory and supervisory
European Union”,19 making the
agencies, such as the Finan-
sector one of the main targets
cial Stability Board (FSB),
for emissions’ reduction. This
as well as the Central Banks
poses serious climate change
and Supervisors.
transition risks that must be
anticipated by real estate de-
According to the Global
velopers. The focus of this
Risks Report of 2021 by the
section is to map the major
World Economic Forum,
climate transition risks, coming
COVID-19 has reinforced
not only from policy and regula-
the need to build more resil-
tion, but also from technological,
ient economies, businesses,
market and societal responses
to climate change. and societies, aiming at re-
sponding more effectively
to known global risks, such
3.2.1 POLICY as health pandemics and cli-
AND REGULATORY mate change 2.
RISKS - WORLDWIDE
Towards achieving the carbon
neutrality goal, the Paris Agree-
ment signatory countries are cre-
ating policies and regulations
that will increasingly benefit cli-
mate resilient businesses, mean-
ing that the path towards decar-
bonization in the global econo-
my is inevitable.
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 6

CLIMATE CHANGE RISKS IMPACTING THE REAL ESTATE SECTOR
03 Task Force on
Climate-related
Financial Disclosures
(TCFD)
In 2015, the Financial Stabili-
ty Board (FSB), upon the re-
quest done by the Ministers
of Finance and the Central
Bank Governors of the G20
countries, created the Task
Force on Climate-related Fi-
nancial Disclosures (TCFD) to
make the assessment of cli-
mate-related risks and oppor-
tunities for companies and
the global financial sector.
Furthermore, and based on
TCFD studies and recommen-
dations, the United Nations
Environment Programme Fi-
nance Initiative (UNEP FI)
showed a strong concern
about the real estate sector
and its climate-related risks,
having released, in 2019, the
study Changing Course: Real
Estate - TCFD pilot project
report and investor guide to
scenario-based climate risk as-
sessment in Real Estate Port-
folios. This report states that:
“With their relative illiquidity
compared to many other
asset types, and from their
physical permanent locations
and long investment cycles,
it is essential that real estate
owners and managers identi-
fy long-term climate change
trends and take adequate
risk mitigation measures to
maintain and enhance value”7.
Central Banks and
Supervisors Network for
Greening the Financial
System (NGFS)
Central Banks and Supervisors
from around the world have
joined forces to promote bet-
ter climate-related risk manage-
ment practices in the financial
sector, mobilizing capital to the
climate transition through NG-
FS.
3.2.2. POLICY
AND REGULATORY
RISKS - EUROPEAN
UNION
Specifically, in relation to the
European Union, the transition
to a decarbonized economy,
alongside with the digital trans-
formation and the regional de-
velopment and cohesion, were
set as key priorities for the next
decades. This awareness and
ambition is reflected in the Pluri-
annual EU budget 2021 to 2027
and the COVID-19 recovery
package Next Generation EU20.
The national plans for recovery
and resilience should have “at
least 37% of their total expend-
iture in supporting climate ob-
jectives” and all investments
must respect the “do no signifi-
cant harm” principle, meaning
that all investments should be
aligned with the EU taxonomy
that defines what environmen-
tally sustainable activities are.21
Actions afecting the real estate sector according to the european green deal
European Green Deal 1. Contribute substantially
to one or more of the environ-
The European Green Deal was launched in 2019 and is considered by the European Commission mental objectives:
as the new growth strategy. It focuses on the strategic areas needed to achieve carbon neutrality
by 2050, aiming at achieving economic growth decoupled from resource use.22 a. Mitigation of climate
change;
b. Adaptation to climate
IMPACT ON REAL ESTATE SECTOR change;
The real estate sector is mentioned as key for this transition. Specific measures under the
c. Use and protection of wa-
European Green Deal are appointed in figure 3. In order to achieve these goals, both regu-
ter and marine resources;
lation and funding will be made available by the EU. This will also be reinforced with other
EU policies such as those described further along in this document.
d. Transition to the circular
economy, waste prevention
FIGURE 3: ACTIONS AFFECTING THE REAL ESTATE SECTOR and recycling;
ACCORDING TO THE EUROPEAN GREEN DEAL
e. Pollution prevention and
control;
Actions afecting the Increased legislation
Decarbonization
real estate sector according related to the energy f. Sustainable healthy ecosys-
of the sector tems protection.
to the european green deal performance of buildings
Legal requirements benefiting 2. Cannot cause significant
Deep dive into circular economy Possibility of the inclusion of
processes for buildings´
secondary markets of construction
emissions from buildings in the damage to any of the environ-
materials with mandatory
construction and renovation European Emissions Trading mental objectives defined
recycled content
above;
Source: European Commission, European Green Deal, 2019 3. Must meet minimum social
criteria (for example, OECD
Guidelines on Multinational
Enterprises and the UN Guid-
EU taxonomy for sustainable activities ing Principles on Business
and Human Rights);
As the EU aspires to align the activities of all economic sectors with the European and glob-
al environmental agenda, the first necessary step to take was to create a common definition
4. Must comply with the taxon-
about what is a sustainable activity. Such definition includes environmental, social and govern-
ance issues (ESG), and the EU decided to start with the environmental aspects. Therefore, omy defined technical criteria.
the existing EU taxonomy23 aims at defining what environmentally sustainable activities are.
According to it, an environmental activity has to:
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 7
CLIMATE CHANGE RISKS IMPACTING THE REAL ESTATE SECTOR
03
IMPACT ON REAL
ESTATE SECTOR
So that renovation and/or
construction, or the purchase
of buildings, is considered
environmentally sustainable,
the sector must comply
with the technical criteria
that the EU taxonomy de-
fines. Such criteria imply sev-
eral minimum requirements
regarding energy consump-
tion, water, waste, pollution
and biodiversity protection.
Since banks and investment
funds are now asked to
disclose the percentage of
the funds aligned with the
EU taxonomy, they will be
requesting a vast range of
environmental information
to real estate companies
about the environmental
performance of all buildings
included in the portfolios
or subject to be financed
by the banks. Also, real es-
tate companies must under-
stand these objectives, the
minimum requirements to
be considered environmen-
tally friendly, and adjust
their construction and man-
agement practices accord-
ing to it.
Disclosure of non-
financial information
The Directive 2014/95/EU, also
called the non-financial report-
ing directive (NFRD)24, identifies
the rules on disclosure of non-fi-
nancial and diversity informa-
tion by large companies, being
compulsory to report such infor-
mation in annual reports from
2018 onwards. The new version
of this Directive is expected to
be released in the first semes-
ter of 2021 and will very likely
include some of the TCFD rec-
ommendations. Therefore, one
can expect that it will become
obligatory for companies to dis-
close their CO2 emissions under
scope 1, 2 and 3 (different cate-
gories of emissions defined by
the Greenhouse Gas Protocol)25,
and to disclose their scenario
planning analysis for a 2°C aver-
age temperature increase.
IMPACT ON REAL
ESTATE SECTOR
Since the NFRD aims at in-
forming the investors about
the environmental, social
and governance (ESG) im-
pacts, and good practices
supported by a set of indi-
cators, the real estate sec-
tor companies must be pre-
pared to respond to the
high level of information de-
mand.
It is already known that com-
panies will have to disclose
their percentage of Turno-
ver, Capex and Opex that
is aligned with the EU taxon-
omy in 2022, in relation to
2021 data. The real estate
sector is included in the tax-
onomy activities and there-
fore, in order to perform en-
vironmentally sustainable
activities/investments, it
has to comply with an exten-
sive list of environmental
issues. If a real estate prop-
erty project is not labelled
as environmentally sustain-
able by investment funds
and banks, that might mean
higher difficulties to access
to capital.
The Renewed EU
Sustainable Finance
Strategy
The Renewed EU Sustainable Fi-
nance Strategy is expected to
be fully launched still during the
first semester of 2021, substitut-
ing the current Action Plan to fi-
nance sustainable growth. It will
strengthen the ambition to align
the entire financial system with
the Paris Agreement goals and
the United Nations Sustainable
Development Goals (SDGs)26 put-
ting an additional pressure on
the private sector to integrate en-
vironmental and social risks into
the financial risk analysis.
Criticisms around poor risk man-
agement and short-term orient-
ed practices of financial institu- Therefore, it will be riskier for the bank to lend money
tions is not new, pushing for the which will increase the interest rate or, ultimately, lead
need for increased transparen- to rejection of the loan. One possible way to respond
cy and long-term focused meas- to this challenge is to have all buildings with a LEED28
ures.27 and/or BREEAM 29 certification, validating the sustaina-
bility value of the real estate assets.
More specifically, the current Ac-
tion Plan to finance sustainable
growth set the call for the:
• Implementation of the EU European Climate Law
taxonomy across all sectors;
Estimated to be launched soon, the European Climate Law
• Creation of standards, la- will set the political commitment of achieving carbon neu-
bels and low carbon referenc- trality until 2050 as a juridical obligation30. This will bring pre-
es; dictability and certainty that the path to carbon neutrality is
irreversible, being especially important to signal to business-
• Inclusion of environmental es, investors and financial institutions that sustainable invest-
risks in the banking and insur- ments are the way to go.
ance prudential ratios;
• Further reinforcement of
non-financial reporting obli- IMPACT ON REAL ESTATE SECTOR
gations.
This can have a large positive impact, since real es-
tate developers can be sure that the decarbonization
ambition will not stop, and as such, investments in
IMPACT ON REAL more efficient buildings aiming at being carbon neu-
ESTATE SECTOR tral, circular on resources, and with improved waste
and water management practices can be given a pri-
Raising capital will be
ority in the real estate developers´ perspective.
linked with how aligned the
assets are with the EU taxon-
omy. Most likely, companies
will be having a taxonomy
rating as they already have
an “ESG” rating. If a build-
ing does not comply with
the taxonomy requirements,
a potential loan attribution
for construction or renova-
tion, might be considered
as not aligned.
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 8
CLIMATE CHANGE RISKS IMPACTING THE REAL ESTATE SECTOR
03 Sustainability-related
disclosures in the
financial services
sector (SFRD)
From March 2021 onwards, a
set of financial players (such as
investment funds, asset manag-
ers, venture capital, private equi-
ties, insurance and financial ad-
visors) have the obligation to dis-
close how they include the ESG
risks in their investment and
remuneration policies. This is
known as the regulation about
the sustainability-related disclo-
sures in the financial services
sector (SFDR)31, and obliges
financial players to publicly dis-
close how:
• Sustainability is embedded
in the financial institution’s
strategies, policies and proce-
dures;
• Each financial product con-
tributes (or not) to sustainabil-
ity;
• The adverse sustainability im-
pacts are taken into account
in their financial products or in
their investments (this one to
be made compulsory from 30
December 2022 onwards).
IMPACT ON REAL
ESTATE SECTOR
The referred fund types will
have to disclose about 32
obligatory indicators and 18
voluntary indicators respec-
tive to their assets, aiming
at responding to the princi-
pal adverse sustainability im-
pacts they might have. This
means that real estate com-
panies will have to be able
to supply that information
to investors so that they are
able to disclose it accordingly.
Capital Requirements
Regulation
Coming into force by June
2022, the Capital Require-
ments Regulation will require
all large institutions with securi-
ties traded on a regulated mar-
ket of any EU member state
to disclose prudential informa-
tion on ESG risks, including
transition and physical risks.32
IMPACT ON REAL
ESTATE SECTOR
With the banks having to incor-
porate ESG factors in credit
analysis, and with the pressure
to state how aligned they are
with the EU taxonomy, since
capital requirements will be di-
rectly related to it, real estate
developers and real estate
companies will be asked to
supply a set of information
about the environmental im-
pacts of the assets. The feasi-
bility and interest rate of the
loans will be also linked to
such alignments.
3.2.3 MARKET AND
REPUTATIONAL RISKS
These risks are related to fac-
tors that are derived from mar-
ket changes and can have rep-
utational hazards in the real
estate companies, comprising
items such as: changing cus-
tomer behaviour; increased
costs of raw materials; or un-
certainty in market signals, like
abrupt and unexpected shifts
in energy costs, or changes in
energy revenue mix and sources.
In the real estate sector, these
risks are directly connected to
the increasing changes in con-
sumer preference for build-
ings with better environmen-
tal performance. For instance,
in the UK, some banks have
developed green mortgages
where consumers have a
better interest rate if they pur-
chase more sustainable flats
/ houses33. This also induces
and accelerates consumer be-
haviour changes towards a
higher demand for greener
buildings. From the corporate
clients´ perspective, there is
a high pressure to track their
carbon emissions and to have
a carbon zero ambition. There-
fore, corporates will also be
looking for greener buildings.
Regarding market signals,
there is a trend towards green-
er buildings and regulation is
having a key role on this. From
the financial players’ side, it is
becoming clear that insurance
might not be available for
buildings with high impact like-
lihood by physical risks, which
also implies a change in the
market, since insurance would
not be available, and with that,
the market value of the assets
would decrease. In fact, inves-
tors are already34:
• Mapping physical risks for
current portfolios and poten-
tial acquisitions;
IMPACT ON REAL
ESTATE SECTOR
• Incorporating physical ad-
aptation and mitigation meas-
This means that real estate
companies, developers and
ures for assets at risk;
construction companies
must consider all the items
• Exploring a variety of strate-
above, while deciding
gies to mitigate risk, including
where to build and how to
portfolio diversification and
do it, since that will have an
investing directly in the mitiga-
impact on the market value
tion measures for specific as-
of the final real estate assets.
sets; and
If they do not incorporate
these concerns, there is a
• Engaging with policymakers
high probability that the as-
on city-level resilience strat-
sets become less attractive
egies, supporting the invest-
for tenants and investors,
ment by cities in mitigating
and that can lead to a lower
the risk of all assets under
market liquidity.
their jurisdiction.
As expressed, both consum-
ers and corporates are grad-
ually becoming more interest-
ed in environmentally friendly
buildings. Investors are also
concerned with the physical
impacts, paying close atten-
tion to the environmental prac-
tices that the real estate com-
panies apply, being also an im-
portant reputational issue and
ultimately, a key decision to in-
vest or not.
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 9
CLIMATE CHANGE RISKS IMPACTING THE REAL ESTATE SECTOR
03 3.2.4 TECHNOLOGY
RISKS
Technology transition risks are
related to the substitution of
existing products and services
with lower emission options, to
the costs of transitioning to low-
er emission technologies, and
to the negative consequences
of not investing in novel and
climate-friendly technologies.
These risks can be high for the
sector, since they imply addition-
al investments on using new ma-
terials and technologies whose
price can be high. Nevertheless,
green technology is developing
fast.
On one hand and providing an
example, according to Bloomb-
erg, “wind and solar are now
cheapest across more than
two-thirds of the world”35, mak-
ing them more cost-effective
to use today. On the other
hand, the calculation of the
cost-benefit effect should also
bear in mind the money that is
saved during the usage of the
buildings, since energy and wa-
ter consumption will be much
less when a building is devel-
oped with environmental con-
cerns. Those savings should
be included in the Profit and
Loss accounts and should be
explained to clients. It is also im-
portant to realize that the price
of water consumption, waste
disposal and even non-renewa-
ble energy consumption can in-
crease in the near future, and
this should also be considered.
As such, the industry is already
taking a lead in addressing cli-
mate challenges, and the World
Green Building Council has
issued a Net Zero Carbon Build-
ings Commitment, advocating
for all buildings to be net zero in
operation by 205036.
This commitment is also visi-
ble by the fact that 1323 com-
panies are now taking action
to achieve 652 targets under
the Science Based Targets initi-
ative37, a partnership between
CDP, the United Nations Global
Compact, the World Resources
Institute (WRI) and the World
Wide Fund for Nature (WWF),
gathering organizations that
assume their commitment to-
wards carbon neutrality, using
science as the base for the defi-
nition of their targets.
IMPACT ON REAL
ESTATE SECTOR
The business model of a real
estate project must include
the future operational savings
coming from less energy and
water consumption in the prof-
it and loss calculations. Those
should be done together with
the CO2 emissions that are
avoided due to the use of
more climate-friendly equip-
ment and technologies. There
will also occur an increasing
need to use new techniques
and renewable materials for
construction.
This allows real estate investors to understand the alignment of their portfolios to the global 2°C target.
Currently, the global Business-as-Usual (BAU) is 3.8°C, meaning that all economic sectors and govern-
In Europe, for example, the
ments must work together to reach the collective goal towards climate change mitigation. According
new buildings will need to be
energy self-sufficient and ide- to the UNEP FI report previously mentioned7, the global average warming potential differs between as-
ally comprising sustainable set types, as the average warming potential for residential buildings is 2.71°C, for retail is 3.12°C, for of-
supply chain networks. It is al- fice buildings being 3.17°C, while for industrial buildings is 3.29°C.
so important to understand
the circular economy con- Still, these numbers do not reflect the reality of specific regions. For example, real estate assets in the
cept applied to buildings, de- South of Europe have one of the highest warming potential levels in the world, meaning that countries
veloping methods that allow in this region will probably be more pressured by governments, clients, and other stakeholders to miti-
the materials used in a specif- gate buildings’ carbon emissions, than in other regions. For a better overview of the emission reduction
ic building to be use later in requirement per m2 as a function of the average value property per geographic region and its building
another one. This implies the types, figure 4 is presented, where the size of the bubble represents the market size.
need to have an inventory
of the materials used in each
building.
FIGURE 4: EMISSIONS’ REDUCTION REQUIREMENT PER M2 WORLDWIDE, BY
Buildings can be a biodiver-
TYPE OF BUILDING AND VALUE PER SQM (USD/M2)
sity enhancer and help
lowering temperatures of cit-
ies, with green roofs/ walls,
which also helps to balance
the interior temperature of
the buildings. On one hand,
this might imply an increase
in the investment. On the
other hand, investors, banks
and insurance companies
are gradually becoming inter-
ested in investing or insuring
buildings that are resilient to
all of these risks.
3.2.5 WARMING
POTENTIAL
The Global Warming Poten-
tial was developed to allow
comparisons between differ-
ent global warming scenario
impacts. Source: UNEP FI, Changing Course: Real Estate - TCFD pilot project report and investor
guide to scenario-based climate risk assessment in Real Estate Portfolios, 2019
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 10
CLIMATE CHANGE RISKS IMPACTING THE REAL ESTATE SECTOR
03 3.3 IMPACT OF
CLIMATE CHANGE
ON LONG-LIFE FIXED
ASSETS
As stated, the real estate sector
is seriously impacted by climate
change, both by transition and
physical risks. This mainly hap-
pens because it is harder to re-
spond to those risks when man-
aging long-life fixed assets, such
as buildings.
Physical Risks
The UNEP FI report mentioned
earlier concluded that “it is
expected that physical risks -
and accompanying damage -
will become more significant
towards the middle of the cen-
tury as temperatures rise and
while most present assets are
still expected to be in service”.7
Therefore, climate risk model-
ling might be a challenging is-
sue. Real estate companies and
investors will have to choose
what time-variable to use and
how they want to consider it
in the different climate change
scenarios identified by the Unit-
ed Nations Intergovernmental
Panel on Climate Change (UN
IPCC). For example, the UN
IPCC business-as-usual scenar-
io, assumes that if emissions
keep rising at current levels,
that will result into an estimated
increase of 4°C in the global av-
erage temperature by the end
of the century, considering sig-
nificant climate-financial risks
and impacts.
Moreover, this scenario analy-
sis will also have to consider ge-
ographical variables, since dif-
ferent regions will experience
distinct increases in tempera-
ture, chronic and acute risks. Al-
though it may seem that taking
an approach of a time horizon
that goes until the end of the
century seems unnecessary,
looking at physical and transi-
tion risks consistently is crucial,
to understand the combined ef-
fect of the aggregated risks in
different scenarios.
Transition Risks
Responding to decarboniza-
tion, regulations will be chal-
lenging as it is expected that,
by 2050, a vast majority of the
current building stock in the EU
will still exist and that a big
chunk of it will still be energy
inefficient. This means that
deep and, potentially, costly
retrofits will have to be done by
real estate companies. Also,
the real estate sector should
take into consideration, not
only the current demands of
public and market regulations,
but also to anticipate future
demands. This is a strong argu-
ment for the investment in
R&D and for the implementa-
tion of new technologies in the
sector.
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 11
TRANSITION TO A CLIMATE RESILIENT REAL ESTATE SECTOR
04 4.1 MAPPING
FINANCIAL RISKS
The overall consensus is that
climate risk is not yet priced
into asset valuations, and this
applies across sectors, includ-
ing bonds, equities and real es-
tate. Nevertheless, due to the
advancement on regulations
and increasing investors’ con-
cerns, one can expect that
to take place in a near future.
In the meantime, the sector
should be prepared to face a
set of important challenges38 39:
• Insurance premiums: The
consequences of climate
change are already making
an impact in the insurance
coverage for assets in vulner-
able markets, through higher
deductibles, reduced cover-
age, and increased premiums.
Insurance can only protect as-
sets from physical risks, and
not from transition risks. For
example, a higher risk of hurri-
canes and other environmen-
tal extreme weather events
in a region, may result in a de-
crease in buyers and tenants,
which constitute risks of illi-
quidity and value reduction
of the assets.
• New accounting methods:
The real estate companies
should include climate risks in
their valuation formulas, name-
ly in what concerns operational
and capital costs, rental growth
or degrowth, potential of insur-
ability, real estate taxes and ter-
minal values.
• Operational costs: Increased
costs for cooling and heat-
ing are expected, as glob-
al temperature increases,
which will result into higher
tenant’s and private owner’s
household bills. Moreover, ex-
treme weather events such
as storms and floods increase
rates of property damage,
leading to additional opera-
tional expenses for repairs.
• Capital expenditures: Pre-
ventative measures to climate
change should be considered
in renovations and new build-
ing developments. These may
come in the form of flood barri-
ers or storm drainage systems,
which will protect assets from
damage incurred during ex-
treme climate events.
• Real estate property taxes:
Governments, especially the
ones placed in more vulnera-
ble regions, may increase prop-
erty taxes in order to protect
infrastructures, limit physical
risks and improve climate resil-
ience.
• Debt availability: Banks
will differentiate loan pricing
instruments or require high-
er equity portions based on
where the asset is located.
Hence, climate-related risks
need to be embedded in the
real estate development pro-
jects´ business plans and fi-
nancial forecasts.
• Investor’s appetite: Inves-
tors will be looking for as-
sets with low climate-relat-
ed risks and with low envi-
ronmental impacts.
• Terminal value: The value
of a real estate project be-
yond the forecasted period
when future cash flows can
be estimated, may decline,
if located in a high-risk area.
4.2 SOCIAL IMPACT
CONSIDERATIONS
If housing has always played
a key role in people’s quali-
ty of life, the COVID-19 pan-
demic has reinforced that
importance, as people have
been obliged to stay home
and to do remote work dur-
ing most of 2020 and 2021.
Buildings’ isolation is an in-
creasingly important factor,
as extreme weather events
become more frequent.
Better isolation, together with The EU Renovation Wave Strategy, published as part of the COVID-19 Europe-
other energy efficient factors an recovery package, aims at overcoming the present barriers of energy and
and the change to renewable resource-efficiency of existing buildings, stating the benefits of a sustainable
power sources, should stabilize approach as “buildings can be made healthier, greener, interconnected within
or decrease the cooling and a neighbourhood district, more accessible, resilient to extreme natural events,
heating expenses of families, and equipped with recharging points for e-mobility and bike parking. Smart
something particularly impor- buildings can provide essential privacy-compliant data for city planning and
tant for low-income families. services”. 41
Moreover, the real estate sec-
tor has the responsibility to
respond to climate change
known consequences (e.g.
sea level rise), addressing
complex issues such as the
hundreds of millions of peo-
ple that have to leave their
homes due to these kinds of
events.
The transition to a low carbon
and climate-resilient sector
can also have a positive social
impact by creating jobs. In
fact, as suggested by the Eu-
ropean Federation of Building
and Woodworkers, towards
zero-emission efficient and
resilient buildings, “the con-
struction sector is the lead-
ing industrial employer in Eu-
rope, representing 7.5% of
total European employment
and 28.1% of industrial employ-
ment in the EU”, and with
a “very powerful multiplying
effect as one job in construc-
tion generates two new jobs
in the overall economy”, while
playing a critical social role for
the integration of migrants in-
to many European host coun-
tries.40
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 12
KEY RECOMMENDATIONS AND FORESIGHT

05 5.1 DEVELOPING A SUSTAINABILITY

STRATEGY
5.2 INCORPORATING CLIMATE FINANCIAL RISKS AND FOLLOWING TCFD RECOMMENDATIONS

DEFINE A REAL ESTATE DEVELOP A CLIMATE RISKMODELLING APPROACH TO ASSESS INCORPORATE CLIMATE RISKS FOLLOWING
SUSTAINABILITY STRATEGY CLIMATE-RELATED RISKS TCFD RECOMMENDATIONS

Real estate companies should understand
the market and regulatory challenges, faced
as a consequence of the physical and transi-
tion risks they are subject to. As such, they
should develop a sustainability strategy with
a 2030 and 2050 vision, identifying a set of
concrete actions, allowing to respond to the
several issues raised in this document.
Since buildings are expected to reduce dras-
tically their carbon emission, the strategy
should consider the usage of more efficient
processes, switching to renewable energy
sources and implementing sustainable pur-
chasing policies. In relation to the emissions
that need to be compensated, the real es-
tate companies should identify projects
that allow them to purchase carbon credits
or to sequester carbon.
Real estate companies should include a climate-related scenario analysis in their de-
cision-making process, so that the assets built or bought can have lower climate
risks. As such, they should develop a methodology to create a scenario analysis
framework, covering the:
1. Identification and assessment of appropriate climate-related scenarios;
2. Development of reporting formats towards disclosing the results of the scenario
analysis;
3. Apply a continuous monitorization and enhancement of the disclosure method-
ology.
To help, companies can use the climate change data analytics tool produced by
Carbon Delta referred in the UNEP FI report7, which can be especially useful for:
• Understanding the Warming Potential issue, which in turn will provide major in-
sights on how the assets and portfolios are benchmarked against global targets;
The real estate companies should follow the TCFD Recom-
mendations of the Task Force on Climate-related Financial
Disclosures, namely the disclosure of the following critical
aspects:
• Governance: The real estate organizational governance
practices around climate-related risks and opportunities;
• Strategy: The actual and potential impacts of climate-re-
lated risks and opportunities on the organization’s business,
strategy and financial planning;
• Risk Management: The identification, assessment and
management of climate-related risks;
• Metrics and Targets: The risks definition, metrics and tar-
gets used for their management.

Real estate companies must also include the
creation of a non-financial reporting system
to respond to a set of indicators requested
by investors and banks. Some can be about
energy efficiency levels, the use of renewa-
ble energy sources, the water management
systems’ practices, or related to the type
of certifications the buildings have. Putting
this strategy in place will mean for the real es-
tate companies to do a set of investments to-
wards building renewable-energy infrastruc-
tures and retrofitted buildings.42 A good plat-
form and tool to help in this process is the
Greenhouse Gas Protocol.43
• Comprehending underlining transition risk values, which will help identifying
the regions with highest climate transition risks. Investors may want to start decar-
bonizing their portfolio in areas with greater transition risks, since those will have
a larger impact in the short term. These can be inferred from studying the areas
where the defined reduction commitments are greater, and where the portfolio’s
highest value assets (or group of assets) are located;
• Understanding how to spot and assess the outlier assets with particularly high-
er climate risks, undertaking different responses such as: ensuring that buildings’ de-
sign is fit-for-purpose; transferring the risks through insurance; or, at the extreme, of-
floading the risk by selling the assets.

FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 13

KEY RECOMMENDATIONS AND FORESIGHT
05 5.3 DEVELOPING SUSTAINABLE PROPERTIES
AND APPLYING CIRCULAR TECHNOLOGIES
5.4 FACING SUSTAINABILITY AS A FINANCIAL LEVERAGE
ASPECT
DEVELOP PROPERTIES WITH GREEN
LABELS
Companies should consider greening their buildings,
by developing their construction and renovation plans
in a way that allow them to obtain international build-
ing labels like BREAM or LEED. Real estate companies
should also be aware that changes will be made to
the EU Renewable Energy, the Energy Efficiency Di-
rectives and the EU Emissions Trading System (ETS),
which will include eco-design and labelling measures.
5.5 REPORTING ON SUSTAINABILITY PRACTICES
USE EFFICIENT TECHNOLOGIES THAT
ALSO ACCOUNT FOR MATERIAL
REUTILIZATION
Identify low carbon and circular economy technolo-
gies, taking into account the new EU Renovation Wave
Strategy, and the European Green Deal, focusing on
energy production, raw material re-usage and biodiver-
sity enablement. Other key actions include the digitali-
zation of assets to measure and assess sustainability,
such as digital services to monitor consumption - and
thus CO2 emission levels’ – helping to identify new risks,
opportunities and sustainable solutions.
ENFORCE SUSTAINABILITY AND CLIMATE-RELATED
PRECAUTIONS AS POSITIVE FOR ACCESS TO CAPITAL
EU Public Grants: For European companies, the EU Renovation Wave
strategy, released as one of the responses for COVID-19 economy crisis,
is expected to provide public grants to ensure higher rates of green reno-
vated buildings.
Investment Funds and Banks: Investment funds and banks will start ask-
ing for a set of indicators that need to be supplied by real estate compa-
nies. They should understand which indicators are expected to be report-
ed and prepare the systems in place to supply with such data, at least, annually.
PROVIDE ANNUAL NON-FINANCIAL REPORTS ON
SUSTAINABILITY MEASURES
Many large companies are already requested to annually report their non-fi-
nancial information. The second version of the EU Directive (NFRD) com-
prised in this document is about to be published, and more items are ex-
pected to become obligatory for companies to report, namely the percent-
ages of Turnover, Capex and Opex that are aligned with the EU taxonomy.
Real estate companies should have an annual report on non-financial infor-
mation, including reporting that follows the TCFD recommendations and
explaining how they are aligned with the EU taxonomy.
They should also start to report the Principal Adverse Impacts (PIA) indica-
tors as described in the Final Report on Regulatory Technical Standards
published in February 2021 by the European Securities and Markets Author-
ity (ESMA), the European Banking Authority (EBA) and the European Insur-
ance and Occupational Pensions Authority (EIOPA).44
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 14
FINAL REMARKS
06
On the one hand, transition cli-
mate financial risks (regulation,
technology, market and repu-
tation) are and will be strongly
felt in the short run. Buildings
that are more energy efficient
and made from low-carbon
materials will constitute an
increasing push from govern-
ments, clients, and investors.
This can become an opportu-
nity for the real estate sector
to renovate and innovate in
its portfolio of assets, since
green subsidies and other sus-
tainable finance incentives
should decrease the cost of in-
vestments.
On the other hand, it is likely
that physical risks will be an
increasingly stronger factor
for value impairments in real
estate assets. Extreme weath-
er events will cause damages
that increase maintenance
costs and, in worst case sce-
narios, may cause total assets´
impairment. These will create
higher insurance premiums
and capital costs, especially as
governments, regulators and
supervisors augment their
pressure to include climate-re-
lated risks in the financial risk
analysis of banks and other
financial institutions (through
the TCFD, the EU taxonomy
or the SFRD to provide some
examples).
For this reason, real estate in-
vestors are also demanding
for more environmental-relat-
ed information before decid-
ing which assets to buy or sell,
because climate resilient real
estate companies are increas-
ingly perceived as organiza-
tions with better risk manage-
ment practices, and thus, as
investments with a greater
potential to generate higher
returns.
Integrating sustainability in a
holistic perspective in the core
strategy of real estate busi-
nesses is key to mitigate these
risks. This paper presents es-
sential recommendations for
real estate companies, allow-
ing for the identification of
new markets, technological
and financing opportunities
that shall lead to business pros-
perity in a sustainable-minded
real estate sector.
FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 15
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30European Commission. (s.d.). European Climate Law. Retrieved from https://ec.europa.eu/clima/policies/eu-cli- 42Pronestì, D., & Pronestì, G. (2020, June 19). How COVID-19 and the climate are transforming the real estate sector.
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the financial services sector. Retrieved from https://eurlex.europa.eu/legal-content/EN/TXT/?uri=celex-
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governance, risk management and supervision of credit institutions and investment firms. Retrieved from https://ww-
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es/green-home-mortgage/

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35
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FINANCIAL RISKS FROM CLIMATE CHANGE FOR REAL ESTATE COMPANIES 17

ABOUT

Sonae Sierra is an international real estate company committed to

delivering solutions to meet its client ambitions.

With over 30 years’ experience in developing, investing and managing

retail real estate across four different continents, at Sonae Sierra we
have unrivalled expertise and an enviable track record of success
behind us.

The sustainability credentials of our real estate assets, and those of our
clients, is of the utmost importance to us and we have long been
committed to looking at ways to reduce costs and improve efficiency.

If you are looking for the best pathway and bespoke tools to unleash
your true sustainable value in real estate assets, uncover sustainable
opportunities, improve competitiveness and increase revenue over
time, let’s get in touch.

Daniel Santos
dacsantos@sonaesierra.com

sonaesierra.com

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FINANCIAL RISKS FROM
CLIMATE CHANGE FOR
REAL ESTATE COMPANIES

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